Use of ijarah sukuk by Islamic banks - Essay Example

? Ijarah Sukuk Task: Ijarah Sukuk Introduction In terms of financial management, there are various financial instruments usedby both wealth and poor investors. In this paper, we are going to discuss the use of ijarah sukuk by Islamic banks in meeting its financial obligations. In addition, the discussion is going to dwell on acquisition of liability and assets and their application in enhancing markets to help the Muslim community. The paper will analyze the both the merits and demerits of Ijarah sukuk and its difference with conventional lease bond. The evaluation will also cover the consistency between Ijarah sukuk and Maqasid al-sharia and its implications over financial transactions affecting the Muslims. 1. Contentious Islamic financial Instruments Ijarah Sukuk is a type of sukuk based on leased assets, involves securities of the same value of every issue, and stands for long lasting physical assets. These assets are attached to an ijarah contract that is based on Shari’a. On that note, there are several reasons why Ijarah Sukuk is considered a contentious financial instrument. For example, Ijarah Sukuk permits corporate customers access to other methods of Islamic refinancing. In addition it grants Islamic organizations a way of handling their liquidity. In contrast, lack of global standards on the acceptable commodities facilitates the establishment of an appropriate global interbanking market (El-Gamal 2006, p.186). Furthermore, there is always the problem of over taxation because Ijarah Sukuk holders possess assets that they fund such as capital gains tax, value added tax and double stamp duty land tax. This affects its growth as the minimum revenue accrued is diminished during over taxation. Similarly, Ijarah sukuk is viewed as a contentious financial instrument because it only offers securitization. Ijarah sukuk and not any other lease bond securitize this means that the revenue produced. There is also the issue of principal-agent challenges. This entails lack of financial capability by Islamic banks to manage its principal-agent challenges. Therefore, this affects long-term funding due to insufficient credit in the market. In this case, a bank may decide to use readily accessible conventional lease bonds because ijarah sukuk is not applicable for long financial projects (Ayub, 2009, p.65). Alternatively, there is the unavailability of ijarah sukuk investments in the market especially to low-earning businesspersons. It is only available to wealthy men hence it widens the space between the rich and poor. On that note, we can say that ijarah sukuk needs organizations with many assets and these assets must not be impeded by other factors. Furthermore, deals involving ijarah sukuk are often deficient of legal infrastructure within upcoming markets especially in relation to trusts or property. On the other perspective, less designed variants of sukuk gets disheartened by the economic likeness of ijarah sukuk and fixed-income goods of conventional lease bonds because of the ideologies of profits and loss sharing. There is also the investment law that governs ijarah sukuk whereby limitations of foreign ownership transfer taxes with large ownership may deter the genuine sales of an asset. Another contention with ijarah sukuk is its complex structure when granted in a non-Islamic nation may result to attempts to counter the problem of designing a tax proficient structure that complies with Shari’a (Lewis & Hassan 2007, p.54). Additionally, ijarah sukuk as a financial tool requires care in terms of bank considerations. This is because of the tendency of sukuk transaction to establish a shared interest of beneficial possession for the sukuk proprietor. 2. Differences and similarities between Ijarah Sukuk and the conventional lease bond There are various similarities and disparity between Ijarah Sukuk and the conventional lease bond. In our case, we will begin with the differences. For instance, the role of sukuk in the Islamic finance perspective is sharing. Therefore, those in possession of sukuk certificates should allocate themselves the profits generated from funded enterprises or from their revenues. However, in conventional lease bond, depositors are only permitted to receive the prevailing deposit rate while the proprietors receive the real profit (Steinbach & Werner 2007, p.182). Additionally, Ijarah sukuk comprises the ultimate way for controlling the modest savings of a majority of Muslims to be used in some main prospects or public finance. On the other hand, conventional lease bond can be attained through Islamic banks. Similarly, it lacks the Islamically workable instrument for acquiring public fiance like Ijarah sukuk. On that aspect, ijarah sukuk grants a few merits of the privatization of economic ventures owned by state without the challenge of ownership transfer, which was formally funded by taxpayers to specific persons. This occurs because sukuk lets the buyers split the profit or revenue of economic enterprise belonging to state without shifting of its ownership. Alternatively, ijarah sukuk grants the Muslim masses the means of changing their sukuk shares into cash in case there is developments in the secondary markets while in conventional lease bond it’s the opposite. This calls upon the state to improve on these markets for the benefit of the larger Muslim masses. Similarly, if there is development in the secondary markets, ijarah sukuk gives exceptional chance for Islamic banks and other financial organizations to control their liquidity. Similarly, these organizations can buy sukuk if they have extra liquidity or if they want liquidity, they can sell the sukuk at the secondary markets. However, in the conventional lease bond, this is not attainable (Cizakca 2009, p.240). In addition, ijarah sukuk is able to attain the main economic goal of Islam by giving all members to share in the genuine profits. This cannot apply when conventional lease is used because it is exclusive to certain investors. On that aspect, ijarah sukuk permits fair sharing of income in the society and ensures wealth is distributed in a wide area thus does not favor the wealthy as witnessed in conventional lease bond. Another significant dissimilarity between Ijarah sukuk and conventional lease bonds is that the latter does not signify possession on the side of bondholders. This is to mean, it only records the debt bearing interest payable to the bondholders by the issuers. However, Ijarah sukuk does not grant capital invested in bonds. Furthermore, in conventional lease bonds whenever interest payments are done to conventional bondholders, the total interest is calculated as percentage of the total invested capital and not real profit percentage as observed in Ijarah sukuk. Similarly, unlike in Ijarah sukuk, which has no substantial returns, conventional bonds assure the outcome of principal at maturity irrespective of the realized loss or profit from the business. On that account, the issuer is not under obligation to give returns beyond the invested principal or the rate of interest. In addition, genuine profits generated from the business accumulate only to the issuer. On the flip side, Ijarah sukuk offers compensation to the sukuk holder through participation in the genuine profits or revenues accrued from the business (Visser & Visser 2009, p.64). However, there are numerous of similarities as the paper stated above. For example, both Ijarah sukuk and conventional bonds are in certificate format utilized during business dealings. Additionally, they are both securities that assist the issuer to obtain a liquid pool of excess capital. Similarly, both are freely transferable from one area to the other of business. They also tender their payment to regular coupons (Attia 2007, p.187). On that note, both ijarah sukuk and conventional lease bonds are under supervision of a trustee. In addition, both are only redeemable at maturity with appearance in the market and a valued rate of interest. 3. Theory and practice with regard to Ijarah Sukuk There is a minimal gap between theory and practice concerning Ijarah and Sukuk. For instance, in theory Ijarah sukuk is viewed as a financial device intended to organize resources originating from the market. This is provision of ijarah sukuk only if one has a strong balance sheet, goodwill, record of accomplishment and hopes of target project. However, in practice poor investors cannot meet the capacity to acquire ijarah sukuk even with all the requirements mentioned above (Kraty & et al. 2005, p.156). In addition, ijarah sukuk is the conventional bond for the Islamic society with the aim of supporting their financial ventures though in practice it only assists the wealthy in the society. Another glaring gap is that ijarah sukuk has the capacity to perform the positive responsibility of organization of savings on a large scale whereas in reality it only leads to poverty among poor investors. This is because of the high taxes it imposes on its clients, which can be unaffordable to the poor. Furthermore, sukuk has the ability to profit investors and persons with business ventures that have the capacity to produce returns that cater for incurred costs and still leaves some savings. Alternatively, in practice, ijarah sukuk does not profit all investors equally but only those with enough capital to make large investments and generate huge revenues with tangible returns. On the other hand, in theory, the production of ijarah sukuk improves the competence of the financial system. In contrast, in practice, it is not uniform in its competence due to tendency to favor only the wealthy. Additionally, it has the capacity to satisfy the credit needs of business venture and governments through preservation of credit supply that has connection with real assets. However, this does not translate to practice as only few businesses can afford it with the government imposing high taxes (Ahmad 2010, p.128). Another critical point is that while sukuk is considered by many as a fixed-income savings and thus with similarity as a bond in practice, in theory one sukuk is called sakka and it means a certificate or a note. Therefore, this note stands for the monetization of an asset compliant with sharia’h that utilizes more than a dozen valid transaction methodologies. Similarly, ijarah sukuk is able to show types of risks that are fixed-income and other outcome by relating a cap to the outcome and hence improving the security package in the enterprise such as supplementary collateral. On that note, these compositions can be changed to cater for different forms of investor expectations. However, in practice, implementation of fixed-income package requires financial funding that cannot be obtainable to most investors. Another glaring gap concerning ijarah sukuk is that ijarah is capable of being marketed on the minor markets at bargained prices while in theory it cannot be reflected on issuer certificates or notes. On that aspect, in practice ijarah sukuk are debts but in theory, they are ownership that entices people for investment. In addition, in theory, ijarah sukuk possess a sale lease construction whereby the head lease symbolizes the sublease of ijarah model. In this scenario, an issuer obtains ijarah sukuk from the holder of the assets through head leasing then leases them back. On the flip side, in practicality, the tendency of head leasing and leasing back has become a challenge for most low-income investors making it hard to transform the model to a reality (Dewar 2011, p.14). Alternatively, in practice, ijarah sukuk is considered a securitization of acquiring large sums of excellent returns by the prosperous investors in the Muslim society. In contrast, the majority of the ordinary Muslims do not view this form of investment positively as it lacks the ability to cater for their families. This is due to the high interest charges forced on investors in order to generate high returns of acquiring larger profits. 4. Consistency between Ijarah sukuk and Maqasid al-sharia There are numerous consistencies of Ijarah sukuk and Maqasid al-sharia. However, in Islamic banking, Maqasid al-sharia is described as intent and insight that guides the ratification of all or most of the rulings of Sharia’h and has connections to present financial transactions. On that note, financial scholars argue that due to conventionalization of Islamic banks with the assets taking domination, Ijarah sukuk is expected to conform to Maqasid al-sharia in order to appeal to a larger Muslim community. Another issue is high costs and reduced profits gained by ijarah sukuk that are required to comply with sharia’h instruments. In addition, due to the Sharia’h risk faced by a majority of Islamic banks ijarah sukuk is standardized to the interest rate of the market (El Tiby & El Tiby 2011, p.138). On that account, there is also the fear of public disappointment if Islamic banks merge with conventional institutions in the hope of expanding its markets. This, therefore, calls upon the guidance of these Islamic banks within the jurisdiction of Maqasid al-sharia. Additionally, this includes strict compliance with the rulings by sharia’h on the terms of guidance of modern financial transactions. Another consistency of ijarah sukuk is the issue of security of deposits. This means that because of lack of guard for real buying power of deposits when compared to inflation, there is still no assurance of investment accounts by deposit accounts and banks. Therefore, this has called upon the intervention of Maqasid al-sharia through its element of Hifz al-aql. This is the act of facilitating effective decisions and transparency in the current finance transactions (Lewis & Iqbal 2009, p.224). Similarly, because most Islamic banks uphold the sharing of profits and losses, Maqasid al-sharia needs also the sharing of knowledge. On this note, the high revenues collected from wealthy investors in ijarah sukuk are mandated by sharia’h to be transparent and fair and hence evade information asymmetry. This result to lack of free distribution of information among the parties involved in the business transaction. Additionally, the conduct of hiding information from the other party in a business deal is viewed as un-Islamic and is not consistent with the teachings of Maqasid al-sharia. Hence, the requirement of sharia’h is the free sharing of knowledge between several parties in a deal to preserve the culture of Islamic banks. Apart from the case of information asymmetry, other pertinent issues of ijarah sukuk are consistent with the doctrines of Maqasid al-sharia. For example, according to Maqasid al-sharia, sharia’h has three prominent conditions that should govern current finance. On that perspective, the safeguarding of religion goes parallel to the maintaining of these conditions. Therefore, Maqasid al-sharia as being consistent with ijarah sukuk, forbids riba in both divides of asset and liability of upcoming Islamic banks Similarly, according to sharia’h compliance, the liability side of sukuk have not been fulfilling because the adoption of conventional finance (Morris & Salam 2008, p.66). This is considered a breach of the teachings of Maqasid al-sharia in controlling modern Islamic finance. It is significant to add that Maqasid al-sharia insists that profits and losses allocation contracts accrued from any deal between two parties should take huge preference. This is through application of profits and losses in both the economy of the liability and asset through deposits into Islamic banks. Additionally, ijarah sukuk in consistent with Maqasid al-sharia forbids the hoarding of commodities or realized profits and eventual urge to put investments into the globular flow of income or the economy. 5. Areas to improve for the benefits of ijarah sukuk There are various areas to improve for the benefit of ijarah sukuk. For instance, ijarah should be contracted on the present asset or a building and even a yet to be constructed asset. This can only occur if the asset is clearly acknowledged in the contract and does not belong to identified items in the condition that the rent or asset are familiar to both parties at the period of the contract. Additionally, there is the possibility of fixing or provision of floating for ijarah rate on the condition that there is an apparent formula consented with a cap or floor. Therefore, rental has to be explained clearly for the first duration of the lease and for upcoming renewable terms to avoid regular decline by benchmarking. Another method of improving the benefits of ijarah sukuk is through holders of ijarah sukuk equally acquiring possession in the asset, surviving the price risks and related ownership costs and dividing its leases to any of its holders (Dar & Moghul 2010, p.88). Furthermore, because ijarah sukuk has the capability of funding sector projects without the participation of interests; it can hence be issued to solicit finances from the primary financial market. Alternatively, the issuance can enable projects to be started anew or advance already started projects. On that aspect, ijarah sukuk has the potential of being sold in the minor markets at a cost that can be controlled by the market. Another area to improve to make ijarah sukuk beneficial to the Islamic community includes the certification of ijarah. This is through investors gaining half-ownership in the many assets in the transaction by buying an ijarah sukuk certificate. In addition, the area of tradability of ijarah sukuk can be improved through trading of standard sukuk in the principal market. This occurs when the cost is above or below the nominal value on the condition and when there are other investment opportunities. Finally, the structures of leased-based sukuk can be improved by being an option to pre-commitment machinery while concurrently avoiding the issues of sharia’h concerning sale re-purchase. Furthermore, on the side of the interest rate, ijarah sukuk can give a secondary standard for the interest rate duration on the bonds via market rates. On that perspective, the high interests rates charged on ijarah sukuk can be lowered to favor all investors across the market divide (Adam & et al. 2004, p.111). This will hence permit poor investors in the Muslim society to invest in their own Islamic institutions instead of partaking conventional lease bonds. Conclusion In summary, we can note a few issues concerning financial investments in the Islamic world. For example, ijarah sukuk is a form of investment that only favors wealthy investors hence locking out the poor. Alternatively, ijarah sukuk is an option for the Muslim community in exchange for conventional lease bond. Therefore, this limits it to the Islamic countries when it helps them is acquiring their liabilities and assets. In addition, there are significant differences in terms of theory and practice in the application of ijarah sukuk to its clients. Furthermore, ijarah sukuk is under the guidance of Maqasid al-sharia whereby its financial stipulations are under the sharia. References Adam, N et al. 2004, Islamic bonds: your guide to issuing, structuring and investing in sukuk, Euromoney Books, London. Ahmad, A 2010, Theory and Practice of Modern Islamic Finance: The Case Analysis from Australia, Universal Publishers, Boca Raton. 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